Global emerging markets local currency bonds had a tough 2024, but two standout strategies—Capital Group and Colchester—weathered the storm with distinct approaches. Morningstar analysis reveals the key differences driving their results.
The year 2024 proofed disappointing for local emerging market debt, with the fourth quarter particularly challenging. During this period, the US dollar strengthened against other currencies, and heightened rates volatility took its toll on performance. Index heavy-weight Brazil was among the worst performers in the fourth quarter as its currency weakening against the dollar and bond prices sold fell following two interest rate hikes aimed at curbing inflation. For the year, the widely followed JPM GBI-EM Global Diversified index posted a return of just 4.1 percent. Outflows in the Morningstar Global Emerging Markets Bond – Local Currency category persisted with a staggering Euro 4.8 billion outflows recorded for 2024.
In other news, the stake of India in the JPM GBI-EM Global Diversified index stood at 7 percent as the country continued to be included at a rate of 1 percent per month since June 2024 until it reaches the maximum permitted weight of 10 percent by April 2025. The country’s stake will be in line with that of China, Indonesia and Mexico. To allow for the inclusion of India, other markets will see their benchmark weights decrease with Thailand, South African and Poland affected the most.
Capital Group Emerging Markets Local Currency Debt and Colchester Local Markets Bond are two strategies in the Morningstar Global Emerging Markets Bond – Local Currency category that are analyst rated. Although both strategies have Morningstar People and Process pillar ratings of Above Average, they each offer investors something unique.
People
Capital Group Emerging Markets Local Currency Debt applies its unique multimanager approach to the strategy. The portfolio is split into three roughly equally weighted sleeves with experienced investors Kirstie Spence and Luis de Oliveira each managing a sleeve independently and the analyst team looking after the third. Investors in the strategy benefit from a unique style in each sleeve: Spence tends to emphasize fundamental valuations, de Oliveira’s targets out-of-favor but attractively valued securities while the analyst-led sleeve reflects this cohort’s high conviction ideas.
In contrast, investment decisions and positioning at Colchester Local Markets Bond, are driven by the views of the investment committee which comprises all traders, analysts and portfolio managers at the firm, including veterans Ian Sims and Keith Lloyd.
Both teams benefit from a deep and steady analyst bench to support their investment processes, but they are structured differently. Colchester’s team consists of generalists covering both emerging and developed markets debt while Capital Group’s team focuses exclusively on emerging-markets debt. Colchester, however, has experienced exceptionally low turnover in its analyst ranks with just three leavers since its 1999 inception, including two retirements. In contrast, Capital Group benefits from the broader firmwide resources available to the team. In both firms, analyst coverage is robust and effectively supports the overall investment process.
Process
Both teams rely on macro and bottom-up views to form their investment views and shape portfolios. However, Colchester’s approach centers on determining inflation-adjusted real valuations, whether for rates or currency positioning, and investing in the most attractive opportunity set. The final portfolio reflects the investment committee’s highest conviction ideas.
Similarly, Capital Group combines their analyst team’s bottom-up recommendations on rates and currencies with top-down insights from the firm’s macro strategists. The bottom-up research focuses on relative value of debt within and across countries. Within each sleeve, the leadership exercises some discretion in how they use the risk budget, allowing for a more tailored approach that reflect each sleeve’s style. This flexibility can lead to a broader range of return sources across the overall portfolio.
Portfolio
Colchester invests exclusively in the currencies and local currency debt of emerging-markets and limits debt exposure to sovereign and quasi-sovereign issuers, while Capital Group afford themselves more flexibility. Capital Group can make modest forays into hard-currency emerging-markets sovereign (typically around 10 percent) or corporate debt (capped at 5 percent), diversifying their sources of return.
Whereas Capital Group limits individual benchmark country exposures to around 1.5 times the benchmark’s weight, fairly concentrated individual country positions of 20 percent to 25 percent is not unusual for Colchester, exposing the strategy to more idiosyncratic risk than some peers.
However, both teams manage currency exposure actively. The Capital Group team has scope to hedge up to 30 percent of the portfolio’s emerging-markets local currency exposure to the US dollar or other developed-markets currencies which can be helpful during bouts of dollar strength and market volatility. While Colchester can also hedge out currency exposure, they do not have strict limits but are guided by their tracking error target of 150 to 450 basis points.
Performance
Although both strategies have performed well compared to the JPM GBI-EM Global Diversified index and their risk-adjusted performance over the longer term is quite similar (five years and out), the distinct approaches of the strategies lead to different performance patterns in the short term. Colchester’s more concentrated country exposures can lead to higher short-term volatility and underperformance versus its benchmark and peers. For example, the portfolio has sported a meaningful overweight to Brazilian rates since around March 2022 and while this was a strong contributor to meaningful outperformance in 2022 and 2023, this high conviction idea stung in 2024.
Capital Group on the other hand, has less concentrated country positions and a more diversified basket of holdings which can mitigate idiosyncratic risks. Opportunistically investing in inflation-linked bonds or hard currency government debt, has been helpful during bouts of inflation and currency volatility while diversifying country exposure to include off-benchmark stakes to countries such as Turkey, Uruguay and Egypt at times, has also benefited investors by diversifying sources of returns and mitigating downside risk.
Capital Group vs Colchester
Elbie Louw, CFA, CIPM, is senior analyst, manager research at Morningstar Benelux. Morningstar is a member of Investment Officer’s panel of experts.